Sunday, 31 August 2014

Wall Street’s Financial Advice – Is It Trustworthy?

Posted at  02:39  |  in  Finance

According to studies, we all know that Wall Street is a magnetic attraction and an interesting place for all the ambitious finance graduates who graduate from some of the best business schools in the country. Both, Columbia Business School or Harvard Business School, two of the top education institutions in the US, keep sending a significant number of graduates to Wall Street firm, who then seek your investment business. Hence, there are many who think that with well-trained ambitious finance professionals advising you on how to invest your dollars, nothing can go wrong. A fact, often overlooked by the investors is that they need to understand the a concept called “interest alignment” as it has a crucial influence on the performance of investment assets. Though investors should know this, yet they don’t. Why is it so?

What is interest alignment?

Well, the concept of interest alignment can be explained well by employing an example from the fund management business.

Suppose you invest your hard-earned dollars in a plain vanilla mutual fund that charges you a management fee for their services. However the fee is fixed and is independent of achieved performance results. In other words, the fee doesn’t matter on whether or not the fund performs well. It earns the management fee, which is often a couple of percent of assets under management.

To put it in different words, the management and its fund doesn’t care if it creates less money for you as it is getting paid in either way. This won’t be a too sweet deal for the investors who would assume that the fund managers usually earn incentives to do well. If you compare this, for example with a hedge fund, you will see that they charge you only the performance fees. When the fund performs well, so does the manager of the fund; because he gets a bigger pay check for being able to deliver strong results. Hence, interests between investors and fund managers are strongly connected.


The interest alignment problems also do exist with the stockbrokers. In fact, they’re the ones who earn benefit when you make transactions. The more you trade, the more they are able to earn. This is indeed a good value proposition for them but certainly not for you. When you have someone who encourages you to trade just to reap benefits from your provisions, this is not only a bad business practice but it also unethical. Investors need to understand that the interests in the stockbroker business aren’t aligned with the investors and that they might not get the best advice from them.

So, what is the ultimate bottom line? Investors with relationships with Wall Street Institutions, whether wealth management businesses, stockbrokers, mutual fund companies or asset management companies, need to get the entire feel for the underlying incentives that govern the business practices of Wall Street. Always be sure about the fact that anyone who wants your money is already incentivized to work for you. So, investors should only pay heed to Wall Street financial advice when they’re sure that the interests of the client will be put first.

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Jimmy Simond is founder of he share his immense knowledge of finance in this blog. You can follow him on Google+.


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